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Fund Spy

Why Great Funds Need to Close

Morningstar is calling for many funds to shut their doors.

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Recently Morningstar's mutual fund analysts have been calling for high-profile funds to close to new investors with increasing frequency. Christine Benz recommended that Fidelity close  Fidelity Dividend Growth (FDGFX) this April and  Fidelity Mid-Cap Stock (FMCSX) in June. In June, Kunal Kapoor suggested that  Ariel Fund (ARGFX) stop taking money from new investors, and Bridget Hughes said the same of  Vanguard International Explorer (VINEX) in July. Paul Herbert probably took the most noteworthy stand. He suggested in May that Capital Research and Management outline a plan to close  American Funds Growth Fund of America (AGTHX)--one the most popular funds ever.

Given this recent history, we thought it a good time to explain again what we mean when we call for a fund to close and why we do so. There are basically two types of fund closures. In a so-called "soft close" a fund stops accepting money from new investors--those who don't yet own the fund. In a soft close, current shareowners can continue to add to their holdings. In the more extreme and rare "hard close," nobody is allowed to contribute more money to a fund. In general, when we call on funds to shutter their doors to new investors, we're suggesting a soft close. (Although on occasion we think a hard close is in order--witness Laura Lutton's suggestion in May that  Fidelity Low-Priced Stock (FLPSX) stop accepting money altogether.) The primary reason we call for funds to close is to stave off the ravages of what we call "asset bloat."

The worst effect of the asset bloat phenomenon is simple: The more money a fund has in it, the less nimble it becomes. If a fund's asset base increases too much, its character necessarily changes. Think in nautical terms: Smaller funds are quick and easy to maneuver, like speedboats, but big funds are more like cruise ships. And no matter how skilled the skipper, speedboats can do things that cruise ships cannot. The most notorious such case is  Fidelity Magellan (FMAGX), which swelled from a $22 million small-cap fund in 1977 when Peter Lynch arrived to the $65 billion mega-cap fund it is today. Of course, that's an extreme example.

Todd Trubey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.